|Shares Out. (in M):||143||P/E||0||0|
|Market Cap (in $M):||1,193||P/FCF||0||0|
|Net Debt (in $M):||-963||EBIT||0||0|
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The market has presented an opportunity to buy shares of Knight Therapeutics, run by an “Outsider” CEO with a track record of compounding capital at ~30% for two decades, at a fair price. GUD shares are down -22% YTD and while not a cheap stock on traditional metrics, GUD shares are trading at a below average historical valuation and offer an attractive entry point.
I believe an investment in GUD will continue to compound at a double digit rate over a long-term holding period. Therefore, I recommend enterprising investors buy GUD.
Knight Therapeutics (TSX: GUD) is a Canadian specialty pharmaceutical company. GUD follows a unique and differentiated business model, allocating capital as follows:
Acquiring and in-licensing late stage or recently approved prescription and OTC pharmaceutical products to sell in Canada and internationally in a range of therapeutic areas.
Secured lending to small pharmaceutical companies.
Investing in pharmaceutical venture capital funds in order to earn attractive returns while getting access to product deals.
An investment in GUD is a bet on the capital allocation skills of its founder and CEO, Jonathan Ross Goodman. He is GUD’s largest shareholder with 21.85mm shares (15.3%). He has stated that he won’t sell a single share until he sells them all (ie. When he sells the entire company).
Jonathan Ross Goodman co-founded and ran Paladin Labs, which was a 100x bagger between its 1996 IPO and its 2014 sale (~30% CAGR). His father is generic drug pioneer Morris Goodman, Chairman of Canada’s third largest drug company Pharmascience and his brother David is the CEO of Pharmascience.
“I am crazy motivated. I am wired to sell drugs,” -Jonathan Ross Goodman
Paladin Labs (formerly TSX: PLB) went public at $1.50 per share in 1996 on the Vancouver Stock Exchange. On Nov 5 2013, Endo International announced the friendly acquisition of Paladin for C$1.7bn, representing a valuation of 27x EPS, 16.2x EBITDA and 5.6x sales (2014E). The deal closed on Feb 28 2014 with PLB stock at $142.06. From the 1996 IPO at $1.50 to the 2014 sale at $142.00, PLB’s stock compounded at annual CAGR of 29.7%, representing a total return of almost 10,000%. As part of the deal, PLB spun out Knight Therapeutics as a pharma start-up in the spring of 2014.
“If Canada was efficient, I wouldn’t exist”
Since its first day of trading on Mar 3 2014, GUD has compounded book value at 19%. The stock has compounded at 25% from its first days closing price of $3.83. Using the grey market trading price of $2.00 pre-deal closing, GUD’s stock has compounded at 51% since inception.
Since inception, GUD has raised $685mm capital at increasing valuations: $3.50, $5.25, $6.75, $8.00, $10.00. It has lent over $125mm to pharmaceutical companies structured between 15%-20% expected IRRs and committed $125mm to nine venture capital fund managers.
GUD has generated $185mm of net income since 2014, largely through the sale of its Priority Review Voucher for US$125mm. GUD also owns 28.3% of Medison Biotech.
A large portion of GUD’s business value is in its current cash & investments, along with future pharmaceutical sales. The company doesn’t have a significant current earnings stream. Therefore, we will analyze book value and NAV as a yard stick for intrinsic value.
Historically, GUD has traded at an average of 1.44x book value. Recent stock price weakness has brought it down to 1.21x BV. The lowest it ever traded was at 1.0x BV (briefly).
I see 1.0x BV as the downside bear case scenario (-20% return) and a base case as the continuation of double-digit CAGR in share price.
Q2 2017 revenue was $2.5mm, an increase of 119% YoY, driven by sales of Impavido (Leishmaniasis) and Movantik (opioid-induced constipation). Licensed / owned products not yet marketed or just ramping up include:
Probuphine (Opioid addiction)
NeurAxon product (Acute migraine, pain and neurological disorders)
Antibe products (Chronic pain and inflammation)
AzaSite (Bacterial conjunctivitis)
Iluvien (Diabetic macular edema)
Netildex (Ocular inflammation)
ATryn (Prevention of thromboembolic events)
60 degrees products (Tropical diseases)
Advaxis products (HPV-associated cancers)
Neuragen (Pain associated with diabetic and peripheral neuropathy)
Flat Tummy Tea (Herbal detox tea)
FOCUSfactor (Dietary supplement)
FLEXISEQ (Pain and joint stiffness associated with osteoarthritis)
Hand MD (Line of anti-aging hand skincare products)
Crescita products (Dermo-cosmetic products lines)
Assuming 1.0x multiple for its cash, loans and investments plus 5.0x estimated peak future sales of its pharmaceutical portfolio, we get a current NAV of approximately $8.50 per share.
“If someone came to me with a CAD600 million loan, where we could all sleep at night and earn double-digit interest, we do it. That, again, if someone came to me to buy a basket of products for 600 million, where I could sleep at night, I'd do it too”
GUD’s management are conservative, rational and opportunistic capital allocators. They seek “low risk, fair return” deals and don’t use debt financing nor do they rely on product price increases. In 2015, while many specialty pharma companies such as Valeant and Concordia were buying everything in sight and overpaying while watching their share prices skyrocket, GUD stayed out of the frenzy and called for the downfall of these serial acquirors while their stocks (and market sentiment) were near all time highs. Now GUD is waiting patiently to acquire attractively priced assets from distressed specialty pharma companies.
“And we're going to be very disciplined. Listen, at Paladin, there was three years when PanGeo was around that I couldn't buy anything because everything was being overpriced. PanGeo was bidding everything up and we took flak for not doing deals. And we just said, look, they're overpaying, they're overpaying. One day it's going to catch up to them. Sure enough, my father's company bought PanGeo in bankruptcy about three years later.”
“I don't believe products will sell for 8.3 times sales in Canada because there isn't the opportunity to increase prices, like there is in the United States. We got to do it the old-fashioned way, which is sell more products, help more people. With regards to Canada, valuations have got lofty and we're going to be disciplined.”
-Q4 2014 call (Mar 19 2015)
“there's no question that it is a seller's market now, which is why we're not buyers. You don't see us buying a lot of things because we look for long-term IRR and we don't see it in this market, which is one of the reasons why we're – why we embarked on our long-term licensing strategy which allows us to gain access to products without joining the competitive fray. We don't have to compete. We're getting them automatically as part of our investment.”
-Q1 2015 call (May 13 2015)
“I would love to buy EBITDA. I just want to pay a fair price for it. I'm not ready -I'm building Knight for my grandchildren, so I don't. I'm not building it for the next quarter or the next year. So I'm not ready to overpay for an asset just to make numbers and certainly not ready to take on debt to finance it.
We think there will be products for sale, there will EBITDA to acquire but it's going to be later on the year, first quarter next year as things kind of unwind. I'm certainly hoping for that and there will be purchases at a fraction of the price that people are paying for assets, for what people pay for assets last year.”
-Q4 2015 call (Mar 24 2016)
“If you also recall, I was also saying that a lot of our peers were building houses of cards and essentially it was going to fall and many of them have fallen, but not -- they are not quite there. They're not quite ready to transact. So I think it is going to be, we are monitoring all of our peers and we have many different opportunities we're looking at”
“I've been calling the kind of -- I was saying that the business models that were -- that built Valeant and Endo were eventually going to fall and they did. That being said, I'm not sure existing management will sell the business that two years ago they bought for 3.2 billion for what it's worth, which is not that. So I think there is going to have to be some changes at Endo before we have an opportunity to purchase Paladin back again.”
Attractive IRRs and low risk profiles are key factors that drive GUD’s capital allocation strategy. Their “edge” comes from focusing on small, inefficient markets such as Canada and Israel.
“I believe, fundamentally, the best values come in markets that are inefficient. I love inefficiency. Canada is not really one pharmaceutical market, it's really 10, because each province dictate what they will and will not reimburse.”
“Israel is a market that is basically the size of Quebec, and is crazy complicated. It's a market that no one cares about. I love markets that no one cares about, because of the inefficiencies, because we can get great deals. And so, I think that's where the deals will be. But, again, we're very -- opportunology is our middle name. So if a deal comes in, that is in -- our preference, of course, is Canada and Israel, because we have a presence there. But if the opportunity is in an another geography, and it makes sense, and we could sleep at night, and there is great inefficiency in the selling price, yes, we'd look at it”
-Q2 2016 (Aug 11 2016)
Management truly cares about long-term value creation and sticks to their strict IRR and low-risk capital allocation strategy. They continue to wait for distressed sales and have indicated their willingness to buy back Paladin (for far less than they sold it for). Utilization of significant dry powder for an accretive acquisition could be a catalyst over the near to medium term.
“we're not going to do deal just to do deals. As I mentioned many times that investment in Knight is investment for your grandchildren. We are going to be patient and wait until it becomes a buyer's market. And when it does, we're going to be pouncing.”
-Q2 2017 (Aug 10 2017)
Why Does This Opportunity Exist?
The stock is down -22% YTD on non-fundamental factors. The TSX small cap index is down -8% YTD, the health care index is down -13% and some small cap funds are down as much as -30%. The health care sector in Canada has been decimated after the blow-ups of nearly all of the companies in the sector (excluding Knight) – Valeant, Concordia, Patient Home Monitoring, Nobilis, CRH Medical, etc. Sentiment in the sector remains horrible. Knight’s results have been steady-as-she-goes and nothing in its most recent results can explain the sell-off in the stock.
In addition, some investors with a short term view may lack patience to stick with GUD’s relatively slow pace of business development activities and long-term timeframe.
A recent sell off in the shares of Knight Therapeutics amid solid performance presents the opportunity for long-term investors to invest with an excellent capital allocator at a fair price. I expect an investment in GUD at these levels will compound at an attractive rate of return.
Key man risk: Jonathan Ross Goodman suffered a near-fatal cycling accident in 2011 and continues to suffer from brain damage. However, his performance as CEO for GUD has been excellent thus far.
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